Forensic Economics Explained

Forensic economics is the application of economic analysis to legal disputes. Forensic economists are retained to quantify economic damages - the financial losses a person has suffered or will suffer as a result of an injury, death, wrongful termination, or other actionable event. Their work translates the facts of a case into a structured, defensible damages calculation that can be presented in litigation.

Forensic economics is distinct from vocational rehabilitation and life care planning, though the disciplines often work together. The vocational expert identifies what jobs the injured person can perform and what wages those jobs pay. The life care planner identifies what future medical care will cost. The forensic economist takes those inputs, applies economic methodology, and calculates a present value of total losses. In wrongful death cases, the forensic economist calculates the economic contribution the decedent would have made to surviving family members over the course of a projected working life.

A forensic economist is not a general-purpose economist. The work requires specific knowledge of wage data sources (primarily Bureau of Labor Statistics publications), actuarial tables, discount rate methodology, personal consumption deductions in wrongful death cases, and the worklife expectancy literature. Practitioners typically hold doctoral degrees in economics, applied economics, or finance, and many belong to the National Association of Forensic Economics (NAFE) or the American Academy of Economic and Financial Experts (AAEFE).

Lost earnings calculations cover the income a plaintiff has already lost from the time of injury through the date of trial or settlement (the "past" damages component) and the income they will lose in the future (the "future" component). Past lost earnings are typically straightforward: they reflect actual wages not earned during a period of disability, with adjustments for any income actually earned during the period.

Future lost earnings - or more precisely, lost earning capacity - require projections. The economist must project what the plaintiff would have earned absent the injury (the "but for" scenario) and what the plaintiff will earn given their current condition (the "with injury" scenario). The difference is the economic loss. Each side of this calculation involves assumptions about wage growth, worklife expectancy, and fringe benefits that must be grounded in peer-reviewed data sources (Skoog et al., 2011).

Earning capacity is distinct from actual earnings. A person who was unemployed at the time of injury had an earning capacity based on their skills, education, and the labor market - even if their actual earnings were zero. Courts and economists recognize that individuals are entitled to recover for the loss of their capacity to earn, not merely for the specific wages they were receiving at a particular moment. This distinction is particularly important in cases involving young plaintiffs, homemakers, students, and self-employed individuals whose tax returns may not accurately reflect their economic contribution.

A dollar received in the future is worth less than a dollar received today because money available now can be invested and earn a return. Present value methodology is the technique by which a stream of future losses is converted into a single lump-sum equivalent in today's dollars. This conversion is necessary because litigation produces a one-time payment, not an annuity.

The present value calculation requires a discount rate - the assumed rate at which money will grow over time. Forensic economists disagree on the appropriate discount rate, with some using U.S. Treasury bill or bond rates (representing a risk-free investment), others using a "total offset" method that assumes the discount rate equals the wage growth rate (producing a result equal to simple undiscounted future losses), and others using more sophisticated models. Jones & Laughlin Steel Corp. v. Pfeifer, 462 U.S. 523 (1983). The choice of discount rate can materially affect the final damages figure in large, long-duration cases.

Some jurisdictions have rules or preferences regarding present value methodology. Courts in certain states have adopted the "Alaska Rule" or variations of it, requiring the total offset method (a discount rate assumed equal to wage growth, which eliminates net discounting), while others leave the methodology entirely to the expert. Beaulieu v. Elliott, 434 P.2d 665 (Alaska 1967). Counsel should be aware of the applicable jurisdiction's law and judicial preferences before selecting an expert or reviewing an opposing report.

Household services - the unpaid labor individuals perform in maintaining their home and caring for family members - are an economic contribution that has real value even though no paycheck is issued for it. When an injury prevents a person from performing household tasks they previously performed, the cost of replacing that labor is a compensable economic loss.

Household services typically include meal preparation, house cleaning and maintenance, laundry, childcare, lawn care, and routine home repair. The forensic economist values these services using replacement cost methodology: what would it cost to hire others to perform the tasks the plaintiff can no longer perform? This requires data on both the time the plaintiff spent on household tasks and the wage rates of workers in the relevant occupations (U.S. Bureau of Labor Statistics, n.d.).

Time-use data from the Bureau of Labor Statistics' American Time Use Survey provides the primary empirical foundation for household services analysis (U.S. Bureau of Labor Statistics, n.d.). The economist computes a base number of hours devoted to household services, adjusts for the plaintiff's specific household circumstances (presence and ages of children, for example), and multiplies by the appropriate wage rate. In wrongful death cases, household services analysis quantifies the value of the services the decedent would have performed for the surviving family members over a projected lifetime.

In wrongful death cases, a forensic economist must account for the fact that some portion of the decedent's earnings would have been spent on the decedent's own personal consumption rather than benefiting the surviving dependents. The "personal consumption deduction" removes the decedent's self-directed spending from the gross earnings projection to arrive at the net economic contribution to survivors.

The magnitude of the personal consumption deduction is determined empirically from consumer expenditure data (U.S. Bureau of Labor Statistics, n.d.; Patton & Nelson, 1991) and depends primarily on family size and income level. In general, smaller families have higher personal consumption percentages (because fixed household expenses are divided among fewer people), while larger families have lower percentages. The deduction is a point of frequent contention between plaintiff and defense economists, and its calculation involves methodological choices about which expenditure categories to include.

Other adjustments that arise in forensic economics calculations include fringe benefit valuation (employment-related benefits such as health insurance, retirement contributions, and payroll taxes have real economic value that must be added to base wages); taxes (some jurisdictions allow the defense to introduce evidence of income taxes as a mitigation of gross damages, while others prohibit it); and worklife expectancy (how many of the plaintiff's remaining years would have been spent working, as distinct from years of life expectancy).